Public companies have seen their earnings fall, in aggregate, over the past several months. That is not a great sign for the health of the bull market, which is driven in large part by expectations of companies’ growth. When those expectations fall short, the market can stumble. As we discussed in a recent research note, analysts often view such “earnings recessions” as an indicator of economic weakness, though the relationship between corporate earnings and economic health is somewhat fluid.
At present, Wall Street analysts appear starkly divided on what the consequences of a continued earnings recession could mean for the economy, as can be seen from a trio of research notes published on Oct. 7.
Morgan Stanley is getting nervous
Morgan Stanley (MS, Financial) has taken a rather pessimistic view. Combined with signs of a severe manufacturing index slowdown, the investment bank’s analysts now fear another weak earnings season could kill the jobs market:
“There are many leading indicators suggesting the jobs market is about to roll over and we think one more weak earnings season could be the straw to break the camel's back.”
While an earnings recession alone may not be enough to indicate economic danger during an expansion, it could prove more powerful and important during a time of elevated economic uncertainty. Combined with the manufacturing indexes showing trouble, as well as macroeconomic headwinds from the ongoing trade war with China, a weak earnings season may be enough to shake market confidence.
Goldman Sachs still believes in the bull market
Among the more bullish analysts is Peter Oppenheimer, chief global equity strategist at Goldman Sachs (GS, Financial). In his latest research note, Oppenheier made the case that, while there are signs of an earnings slowdown, there is still only limited reason to be afraid of either a sustained earnings recession or a fall into economic recession:
“This downturn in manufacturing has been one of the longest on record and may start to stabilize, if not improve, somewhat soon. Our economists remain of the view that growth has slowed but is not close to recession...Assuming no recession, it is too early to expect this equity bull market to end in our view. While avoiding a recession should support risky assets, the upside is somewhat limited by the prospects for continued relatively modest profits growth.”
JPMorgan prays for a trade war truce
While Goldman believes the bull market will survive an earnings blip, Morgan Stanley clearly sees it as a major potential catalyst for a severe economic reaction. To assess the merits of these opposing stances, it is important to consider the broader context, according to JPMorgan Chase & Co. (JPM, Financial).
JPMorgan’s latest research note fretted about the earnings slowdown in light of mounting trade war tensions. As President Trump has affixed much of his reputation to the stock market, an earnings recession could result in political damage. According to JPMorgan, succor may be found in a trade war truce. But even if trade peace is the only path to avoiding a serious financial episode, the Trump administration may be slow to accept it given the bellicose posture it has adopted toward China.
Verdict
The bull market has weathered earnings recessions already, but the market cycle is now much longer in the tooth. With other fundamental economic indicators suggesting, at best, a slowdown, the stock market may find it far harder to shrug off another earnings recession.
The sheer number of economic problem spots should be cause for concern. We might shrug at an earnings recession on its own. Combined with a fragile jobs market, anemic manufacturing and shipping indexes and a general elevation of trade tensions, it is a far more worrying prospect.
Disclosure: No positions.
Read more here:
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